The issue of startup founder salaries is a tricky one. Many
entrepreneurs tend to simplify this and pick one of two extremes:

Founders get no pay. (“Salaries,
we can’t afford no stinkin’ salaries…”)

Founders get paid close to fair
market value. (“We raised outside capital so we could reduce
our risk, might as well pay ourselves…”)

I believe that the issue is more nuanced than this and
depends on a variety of factors. Here are some thoughts on founder
compensation

Startup Founder Compensation: The
Good, The Bad and The Irrelevant

Investors vs. No Investors: If you’ve raised money
from angels or VCs, chances are that your salary will be governed to some
degree by your agreement with them. This should not come as a big
surprise. Investors want to protect their interest and in order to
do so, they need to ensure that management doesn’t arbitrarily raise
it’s salaries and extract inappropriate levels of cash from the
company.

Co-Founders vs. No Co-Founders: If you’re the only
founder in the company (and there are no investors), then chances are you
can make the salary decision based on things like available cash, tax
optimization (within the law) and fair market value. Most bootstrap
startup founders tend to minimize the salary they pay themselves as it is
not to their benefit to take large salaries because of tax implications. If
there are two or more founders, things get a little trickier because each
founder will now be impacted by the salary draw of the other (in essence,
the founders are shareholders and as such, are impacted by the allocation of
salary much like investors would be). In this case, salaries are
likely better determined as a function of fair market value (whereby each
founder is working at some fraction of fair market value). Of
course, fair market value is not always easy to figure out – but based
on roles, responsibilities, geographies and experience there is data out
there that can be used to get reasonably close.

Deferred Salary: I often advise startup founders that plan to raise external financing some
day to allocate some “fair market value” salary to themselves,
but simply treat this as a “deferred expense” item on the
accounting books. Basically, this is tracked as a liability for the company.
When an outside investment does come in, some portion of this liability
may be “paid off” (i.e. cash taken off the table when the
investors write the check), or it is maintained as a liability until some
future liquidity event (like when the company is sold). This often
becomes a negotiation point with investors, but a reasonable argument can
often be made for some fraction of the deferred salary to be paid at the
time of financing. One possible tactic to use here is to actually
make a loan to the company
(treated as debt) and pay some salary to yourself from that. The
debt can then be carried on the books and paid when cash is available, or
converted to preferred equity when then financing occurs. [Note:
A deeper discussion of debt, equity, preferred shares, etc. is outside the
scope of this article]

Founder Cash Investment Is Irrelevant: In my mind, whether or
not a specific founder invests cash in the company should not impact her salary and
compensation. These are two separate matters. [Note to
self: Write a future article on how founder cash should be handled
and how founders shares should be distributed]. So, the cash
investment should likely be treated as some form of debt or equity and
does not entitle the founder investing the money to a higher salary.
Further, just because founder X put in some cash (lets say $500,000) does
not mean that salaries should not be paid to founder X, Y or Z. If
the cash is in, it should be treated as a resource of the company and
appropriate things done with it. Having said that, it’s
important to have an agreement as to what can (and can’t) be done
with initial seed investments by founders (much like you’d have an
agreement with outside investors).

Founder Time Is Not Free: Entrepreneurs often make the mistake of assuming
that because they’re not paying themselves, their burn rate (i.e. amount
of money being lost) is low. This is simply not accurate. For
example, if you’re running a Web 2.0 company and paying just
$100/month for the hosted server and working out of your apartment with
another $400/month in expenses, your expenses are not just $500/month. Your time is
worth something. You have an opportunity cost, regardless of what
you decide to pay yourself. It irritates me when these kinds of
founders claim they don’t need to worry about revenues because they
can run their companies “for years” because their expenses are
so low. But, surprisingly, despite this irritation, my life goes
on. (And, not surprisingly, many of these entrepreneurs eventually
figure this out and either start making money, raise more money, or shut
down).

As far as magnitude goes, I think it is unlikely for a
startup founder or executive to make the same amount of money at a startup as she’d
be able to get at an established company. The reason is quite simple –
there’s likely a significant equity component in the equation. Granted,
if you determine the “value” of this equity by discounting
appropriately for risk, it may not be that big. But, it’s still more
than zero. In my case, I tend to use something like 25%-50% of fair
market value to determine salaries (and even then, some of it may be deferred,
based on cash-flows). The rest of the FMV is made up with equity. But,
my behavior is skewed by the fact that my startups have been “internally
funded” and have not had VC investments. For VC-backed companies, I’m
guessing the salary would likely be closer to 75% of FMV (or higher) based on
stage of company. Of course, one can (and should) wonder why anyone would
work for < 50% of FMV for a bootstrapped startup. The answer is that many
of us actually enjoy the startup lifestyle and the autonomy, learning and
energy that goes with it. Though from a financial perspective, it may not
make sense in the short-term, we still continue to do it simply because we like
it – despite the long hours and roller-coaster like swings. Note:
I’m talking here only about founders and executive management. Others
get close to FMV because their equity piece is not that large.

My biggest advice to you if you’re trying to figure
out compensation for the early team is to try and base your decision on some
objective standard and apply that consistently. In these situations, it’s
often just as important to be consistent and fair as it is to be “accurate”.
It’s also important to be transparent about the risks involved. Startups,
and especially bootstrap startups, are not for the faint of heart. If you
have investors, they likely have lots of experience with this and can often act
as a good sounding board (not in terms of magnitude, but at least in terms of
structure).

Summary of my points: This is an important issue and can
lead to much frustration if time is not spent coming up with something that is
clear, transparent, equitable and reasonable. If you’re planning on
raising money, having a rational approach to founder compensation is a good way
to send a positive signal to potential investors. Sometimes, it may help
to have an objective and knowledgeable third-party help work through the
structure (particularly when there are multiple founders involved).